Actuaries can play a major role in helping decentralised financial technologies reach their full potential, says Zhixin Lim
Actuaries have historically thrived in the insurance and risk management industries. While many of us have moved successfully to ‘non-traditional’ actuarial areas, the profession has more to do to become the ‘revolutionary’ elite that Elon Musk hoped for when he tweeted about hiring actuaries to develop Tesla’s insurance proposition. The imminent arrival of fully autonomous vehicles is just one of several technological megatrends that are poised to change our industry and the way we work.
Decentralised autonomous organisation
The lockdowns triggered by COVID-19 have made remote working mainstream. Tools such as Zoom, Slack and Notion enable teams to organise and work together without needing to be in the same place.
Virtual collaboration is not new; numerous open-source software projects are built and maintained by teams of strangers co-ordinating online. Decentralised autonomous organisation (DAO) – an organisational concept and software tool to co-ordinate human and capital resources – is the latest in this trend.
As an organisational concept, DAO is egalitarian. It eschews the traditional hierarchical structure in favour of bottom-up grassroots decision-making. There are no managers, only leaders when there is a need for one. The most influential people in the organisation are those who contribute and add the most value. To solve the agency problem, DAO promotes radical transparency and honesty; interests are aligned through a shared purpose and a set of tangible principles to follow.
As a software tool, DAO provides a trustless way to pool money and facilitate collective decision-making. DAO utilises smart contracts and software code deployed on the blockchain to escrow funds and to allow participants to submit and vote on proposals without the need for a central authority. In some cases, DAO utilises crypto-token economics (‘tokenomics’) to further align the interest of participants.
The blockchain technology underlying DAOs is also changing the provision of financial products and services. Known collectively as decentralised finance (DeFi), these financial products (such as lending, investment and insurance) are digitally native and fully automated. Users interact directly with DeFi, without intermediaries such as banks or insurance companies. DeFi products are governed by a community of users – an approach that harks back to the concept of a mutual, but with improved transparency and governance.
DeFi is still at an experimental stage. It is far from being adopted by the mainstream due to its current limitations and risks. These risks include the design flaws in smart contracts, which can be exploited and result in a loss of fund. As the technology matures, DeFi could be disruptive to the traditional finance industry.
The role of actuaries
Actuaries’ problem-solving skills, and our ability to communicate technical subject matters and provide clarity, will be more valuable than ever. DeFi products, like traditional financial products, need to be designed, and risks need to be priced and managed. Some of these technical challenges will be familiar; for example, in building a DeFi insurance product, how do we mitigate moral hazards, reserve for liabilities, match assets and liabilities, and maintain solvency of the fund? Some areas, such as smart contract risk, will require upskilling, but the management of this risk is similar to model risk management, where actuaries are already making inroads. A higher calling, perhaps, is that actuaries can contribute to the development of a digital financial system that promises to be more transparent and more inclusive. Actuarial work has never been more exciting.
In his book The Pleasures and Sorrows of Work, philosopher Alain de Botton concludes that work distracts us from our mortality. His observation is perhaps less relevant to actuaries, who contemplate death daily while engaging in the modelling, pricing and transferring of longevity and mortality risk. Nevertheless, he has a wider point: work demands myopic concentration on the task at hand. Being busy with work is the perfect excuse to dismiss the bewildering changes around us. The future demands, at the very least, a curious mind. As the science fiction writer William Gibson once said: “The future is already here – it’s just not very evenly distributed.”
Zhixin Lim is a senior investment risk manager at HSBC Asset Management. He writes about technology and business on his personal blog odds-and-ends.net
Understanding blockchain for insurance use cases: https://doi.org/10.1017/S1357321720000148
The basics of DeFi: https://www.odds-and-ends.net/2020/09/29/decentralised-finance-the-basics/
The current state of DeFi: https://www.odds-and-ends.net/2020/10/31/decentralised-finance-defi-the-current-state/